Trade Like a Stock Market Wizard: How to Achieve Super Performance in Stocks in Any Market: How to Achieve Superperformance in Stocks in Any Market

by Mark Minervini

Superperformance Stocks by Richard Love.

Two things are required: a desire to succeed and a winning strategy.

Impossible is just a big word thrown around by small men who find it easier to live in the world they’ve been given than to explore the power they have to change it. —Laila Ali

From the very beginning, I saw the stock market as the ultimate opportunity for financial reward. Trading also appealed to me because I liked the idea of having the freedom to work at home and taking responsibility for my own success. In my young adult years, I had tried several different business ventures, and even though I felt enthusiastic, that burning passion was still missing. Finally, I came to realize that what I was most passionate about was freedom—freedom to do what I want, when I want, where I want.

Freedom

Harvey Mackay said it perfectly, “Optimists are right. So are pessimists. It’s up to you to choose which you will be.”

When I began trading in the early 1980s, I endured a six-year period when I didn’t make any money in stocks. In fact, I had a net loss. It wasn’t until 1989 that I began to achieve meaningful success. What kept me going? Unconditional persistence. When you make an unshakable commitment to a way of life, you put yourself way ahead of most others in the race for success. Why? Because most people have a natural tendency to overestimate what they can achieve in the short run and underestimate what they can accomplish over the long haul. They think they’ve made a commitment, but when they run into difficulty, they lose steam or quit.

You must persevere if you wish to succeed in anything. Knowledge and skill can be acquired through study and practice, but nothing great comes to those who quit.

No one can fire you from your craft the way a boss can from a job;

All you have learned and the experience you have gained can bear fruit for many years to come. Truly, this is what makes acquired knowledge and firsthand experience the greatest tool to succeed and build upon in stock trading and in life.

For me, the greatest success came when I finally decided to forget about the money and concentrate on being the best trader I could be. Then the money followed.

You don’t have to be great to get started, but you have to get started to be great. —Les Brown

Most of all, long-term success in the stock market comes from discipline, the ability to consistently execute a sound plan and refrain from self-defeating behavior. If you have these traits, the odds are that you will succeed.

Refrain from self defeating behavior

My first experience investing in the stock market was with a full-service stockbroker in the early 1980s, and it wasn’t pleasant. In a few short months my entire account was wiped out. Although this was painful and a major setback financially, it turned out to be one of my most valuable lessons about investing.

trade. It wasn’t until I suffered enough big losses that I made the decision that turned my performance from mediocre to stellar: I decided it was time to make money and stop stressing about my ego. I began selling off losing stocks quickly, which meant taking small losses but preserving the lion’s share of my hard-earned capital. Almost overnight, I regained a feeling of control.

them. I saw my portfolio with fresh eyes and finally began to understand that trading is not about picking highs and lows or proving how smart you are; trading is about making money.

Any pattern of action repeated continuously will eventually become habit. Therefore, practice does not make perfect; practice only makes habitual.

Vince Lombardi. As he said, “Practice does not make perfect. Only perfect practice makes perfect.”

If you treat trading like a hobby, it will pay you like a hobby, and hobbies don’t pay; they cost you.

When it comes to stock trading, I know no one who, for example, can successfully trade value in one cycle and then switch to growth the next or be a long-term investor one day and then a day trader to suit the market du jour. To become great at anything, you must be focused and must specialize.

The average trader spends the majority of his or her time vacillating between two emotions: indecisiveness and regret. This stems from not clearly defining one’s style. The only way to combat paralyzing emotions is to have a set of rules that you operate from with clearly stated goals. You simply must make a decision: Are you a trader or an investor? Some people have a personality best suited for trading, and some prefer a longer-term investment approach. You will have to decide for yourself which is best for you. Keep in mind that if you fail to define your trading, you will almost certainly experience inner conflict at key decision-making moments.

Key. Must decide if trader or investor.... what is the tiem frame?

If you are a short-term trader, recognize that selling a stock for a quick profit only to watch it go on to double in price is of no real concern to you. You operate in a particular zone of a stock’s price continuum, and someone else may operate in a totally different area of the curve. However, if you’re a longer-term investor, there will be many times when you make a decent short-term gain only to give it all back in the pursuit of a larger move. The key is to focus on a particular style, which means sacrificing other styles. Once you define your style and objectives, it becomes much easier to stick to a plan and attain success.

Many of life’s failures are people who did not realize how close they were to success when they gave up. —Thomas Edison

unattainable. You may even feel like giving up. I know. I’ve been there. I went six consecutive years without making a penny while pursuing stock trading.

Then, after more than a decade of trial and error, I was making more money in a single week than I dreamed of making in a year. I experienced what the English poet and playwright Robert Browning meant when he wrote, “A minute’s success pays the failure of years.”

Remember, if you choose not to take risks, to play it safe, you will never know what it feels like to accomplish your dreams. Go boldly after what you want and expect some setbacks, some disappointments, and some rotten days. Embrace them all as a valuable part of the process and

learn to say, “Thank you, teacher.” Be happy, feel appreciative, and celebrate when you win. Don’t look back with regrets at failures. The past cannot be changed, only learned from. Most...

Love’s findings convinced me of three empowering points: 1. There is a right time and a wrong time to buy stocks. 2. Stocks with superperformance potential are identifiable before they increase dramatically in price. 3. By correctly investing in these stocks, it is possible to build a small amount of capital into a fortune in a relatively short period.

From Love, I learned historical precedent analysis and the commonalities of superperformance stocks; from Jensen, blueprinting and profiling; from Donchian, trend following; and from Jiler, chart patterns, including his famous saucer with platform, which is now known as the cup-and-handle pattern, popularized by William O’Neil, who also worked at Hayden Stone in the 1960s.

inspiring. Although most people associate Livermore with the book Reminiscences of a Stock Operator, I gravitated to his pragmatic work How to Trade in Stocks. Reading Livermore’s book crystallized my thoughts. Many of the principles that were starting to work for me seemed no different from those that had worked for Livermore back in the first decades of the twentieth century.

stocks. I call this a Leadership Profile, which is an ongoing effort to identify in detail the qualities and attributes of the most successful stocks of the past to determine what makes a stock likely to dramatically outperform its peers in the future. The focus is not just on the magnitude of a price move—how much a stock goes up—but also on the time element of the equation: how fast it goes up and what accounts for the rapid rise.

THE FIVE KEY ELEMENTS OF SEPA The basic characteristics are broken down into five major categories, which make up the key foundational building blocks of the SEPA methodology: 1. Trend. Virtually every superperformance phase in big, winning stocks occurred while the stock price was in a definite price uptrend. In almost every case, the trend was identifiable early in the superperformance advance. 2. Fundamentals. Most superperformance phases are driven by an improvement in earnings, revenue, and margins. This typically materializes before the start of the superperformance phase. In most cases, earnings and sales are on the table and measurable early on. During a stock’s superperformance phase, a material improvement almost always occurs in the fundamental picture with regard to sales, margins, and, ultimately, earnings. 3. Catalyst. Every stock that makes a huge gain has a catalyst behind it. The catalyst may not always be apparent upon a casual glance, but a little detective work on the company’s story could tip you off to a stock with superperformance potential. A new hot-selling product that accounts for a meaningful portion of a company’s sales may provide the spark to ignite a superperformance phase in that company’s stock price. Approval by the FDA, a newly awarded contract, or even a new CEO can bring life to a previously dormant stock. In dealing with small, lesser-known names, it often takes some event to attract attention to a stock. I like to see something that ...

The SEPA ranking process can be summarized as follows: 1. Stocks must first meet my Trend Template (see Chapter 5) to be considered a potential SEPA candidate. 2. Stocks that meet the Trend Template are then screened through a series of filters that are based on earnings, sales and margin growth, relative strength, and price volatility. Approximately 95 percent of all stocks that qualify under the Trend Template fail to pass through this screen. 3. The remaining stocks are scrutinized for similarities to my Leadership Profile to determine whether they are in line with specific fundamental and technical factors exhibited by historical models of past superperformers. This stage removes most of the remaining companies, leaving a much narrower list of investment ideas for an even closer review and evaluation. 4. The final stage is a manual review. A narrowed list of candidates is examined individually and scored according to a “relative prioritizing” ranking process that takes into consideration the following characteristics: • Reported earnings and sales • Earnings and sales surprise history • Earnings per share (EPS) growth and acceleration • Revenue growth and acceleration • Company-issued guidance • Revisions of analysts’ earnings estimates • Profit margins • Industry and market position • Potential catalysts (new products and services or industry-or company-specific developments) • Performance compared with other stocks in same sector • Price and trading volume analysis •...

Although strategy is important, it’s not as critical as knowledge and the discipline to apply and adhere to your rules. A trader who really knows the strengths and weaknesses of his or her strategy can do significantly better than someone who knows only a little about a superior strategy.

This is why it’s important to concentrate on companies that are reporting strong earnings, which then trigger upward revisions in earnings estimates. Strong earnings growth will make a stock a better value.

Most of the best growth stocks seldom trade at a low P/E ratio. In fact, many of the biggest winning stocks in history traded at more than 30 or 40 times earnings before they experienced their largest advance.

Most of the time money in stocks is lost not because the P/E was too high but because earnings did not grow at a high enough rate to sustain expectations; the growth potential of the company was misjudged. The ideal situation is to find a company whose growth prospects warrant a high P/E: a company that can deliver the goods—and the longer it can maintain strong growth, the better.

Seek out companies with the greatest potential for earnings growth. Companies growing revenues at a rapid pace are your best choice.

To illustrate, let’s say Company A is trading at 25 times its earnings for a P/E of 25. If it reports earnings that are 20 percent higher and the stock price remains essentially unchanged, the P/E will drop to 20.83 times earnings. If the stock price jumps 20 percent on the earnings news, the P/E will remain the same at 25 times earnings. Over time, as a stock grows more and more popular and the price rises consistently, its P/E ratio can expand as the stock’s price appreciates at a faster rate than its earnings growth. If the stock rises significantly over 12 to 24 months and the P/E expands by 100 to 200 percent, doubling or tripling from where it started near the beginning or from the bottom of the major price move, it’s possible that the price move is in its later stage and is getting too widely recognized.

Historical study of superperformance stocks shows that the average P/E increased between 100 and 200 percent on average (or two to three times) from the beginning until the end of major price moves. This information can be used in two ways. First, you can get an idea of a stock’s potential. You can estimate what it might sell for as an average best-case scenario within a year or two down the road from your initial purchase price, that is, if you’re buying a dynamic leader in a bull market. You could estimate future earnings and apply the expanded P/E number to get a rough idea of the stock’s theoretical potential. Second, you can gain some perspective on how much of the company’s good fortune has already been discounted by gauging how much P/E expansion has taken place already. Let’s say you buy a stock with a P/E of 20 at its initial breakout from a sound base. Multiply 20 by 2 to 3 to see what the ratio could rise to. That gives you 40 to 60. You hope that the stock continues to rally. Though it’s always prudent to look for sell signals, pay extra attention once the P/E nears 2 and especially around 2.5 to 3 or greater. It could top soon afterward. If this occurs, look for signs of decelerating growth and signs of weakness in the stock price as your signal to reduce your position or sell it out. In the 1990s, as Home Depot stock became an institutional favorite, rampant enthusiasm ran the stock price up well ahead of its earnings growth. Home Depot’s P/E expanded from th...

Stop worrying about the P/E ratio. If you have a company delivering the goods as Apollo Group did, earning 40 percent per annum for four or five consecutive years, whatever the initial P/E was is irrelevant; the P/E takes care of itself. Leave the overintellectualizing and complex theories to the professors and academicians and the valuation tactics to the Wall Street analysts.

When I am screening for superperformance stocks, my initial filter is rooted in strict qualifying criteria that are based purely on a stock’s technical action and is designed to align my purchase with the prevailing primary trend.

Once this initial criterion is met, I run “overlay screens” and look at the company’s fundamentals to narrow the remaining universe of candidates. Simply put, no matter how good a company looks fundamentally, certain technical standards must be met for it to qualify as a buy candidate. For example, I will never go long a stock that is trading below its declining 200-day moving average (assuming 200 days of trading exist). No matter how attractive the earnings per share, revenue growth, cash flow, or return on equity may be, I won’t consider buying a stock that is in a long-term downtrend. Why? I want to see some interest in the stock, preferably from big institutional investors. I’m not interested in being the first one to the party, but I do want to make sure there’s a party going on. The goal is to eliminate stocks that are not worth my time so that I can focus on contenders that have the best chance of being the next superperformers. Buying stocks in long-term downtrends will significantly lower your odds of owning a big winner. However, if you want to increase the odds, you should focus on stocks that are in a confirmed uptrend.

Risind 200dma.. rising

Newton’s first law states that an object in motion continues in motion. Things in motion possess inertia. An analogous property characterizes the stock market: a trend in force tends to remain in force until something occurs to change it. In other words, the trend is your friend.

Stan’s approach was based on a timeless principle of the four stages that stocks go through, placing importance on knowing what stage a stock is in at any specific time. The ideal scenario, as Stan saw it, was to buy stocks when they are coming out of the first stage and beginning to make a run higher, which is the second stage. Then the objective is to sell them as they approach the peak of the cycle, which is the beginning of the third stage. The fourth stage, as you might guess, is a full-fledged decline that you want to avoid or during which you go short. I had previously read about Stan’s approach in his book Secrets for Profiting in Bull and Bear Markets (McGraw-Hill, 1988). Although Stan wasn’t the only one to use this type of four-stage approach, he was the first I heard speak about it. I went on to adopt this concept as part of my stock analysis.

Like all stocks, superperformance stocks go through stages. Over the course of my trading career, I’ve taken a keen interest in studying the cyclical and secular life cycles of stock prices. In particular, in examining the historical price performance of the most powerful market leaders over many market cycles, I could clearly see how they go through various stages. A stock would trade sideways for a while and then move up rapidly. Eventually, the rate of upward momentum would slow and become more erratic as the stock was under distribution and topping out. After a top came the decline. Sometimes, after the decline, the stock returned to a basing stage before eventually making another run upward. The succession of one stage to the next, through all four, could take several years. What I found through my study of the biggest price performers was that virtually every superperformance stock made its big gain while in stage 2 of its price cycle.

phases. From a fundamental perspective, the cause almost always was linked to earnings: from lackluster performance to upside surprise and accelerating growth, eventually followed by decelerating growth and then disappointment. These underlying fundamental changes drove big institutional players into and out of stocks, phases that could readily be identified by the huge volume spikes that occurred during both the advancing stage and the subsequent decline.

1. Stage 1—Neglect phase: consolidation 2. Stage 2—Advancing phase: accumulation 3. Stage 3—Topping phase: distribution 4. Stage 4—Declining phase: capitulation

STAGE 1—THE NEGLECT PHASE: CONSOLIDATION Stage 1 is when nothing noteworthy is happening. The stock is in a period of neglect; few big players are paying attention to the stock, or at the very least, the market has not yet paid up for the company’s shares. During stage 1, a company’s earnings, sales, and margins may be lackluster or erratic along with its share price. There may also be an uncertain outlook for the company or its industry. Nothing electrifying is happening to push the stock out of its doldrums and attract the needed institutional volume support to move it decisively into a stage 2 uptrend. Stage 1 can last for an extended period, from months to years. Stage 1 can also be caused by a poor overall market environment. During a bear market decline, even stocks with good fundamentals can mark time and do nothing or even decline along with the overall market. You should avoid buying during stage 1 no matter how tempting it may be; even if the company’s fundamentals look appealing, wait and buy only in stage 2. Remember Newton’s first law, the law of inertia. An object in motion tends to stay in motion, and one at rest continues at rest. If your stock is dead in the water, guess where it’s most likely to stay until something significant changes. You’re not going to achieve superperformance by sitting with dead merchandise. To compound capital at a rapid rate and achieve superperformance, it is vital that you avoid stage 1 and learn to spot where momentum is strong...

These stages seem to be the core of the book

I can tell you from experience that attempting to bottom fish—trying to buy a stock at or near its bottom—will prove to be a frustrating and fruitless endeavor. Even if you are fortunate enough to pick the exact bottom, making significant headway usually requires sitting without much progress for months and in some cases years, because when you buy a stock near its bottom, it is in stage 4 or stage 1 and therefore by definition lacks upside momentum. My goal is not to buy at the lowest or cheapest price but at the “right” price, just as the stock is ready to move significantly higher. Trying to pick a bottom is unnecessary and a waste of time; it misses the whole point. To achieve superperformance, you need to maximize the effects of compounding; thus, it’s important to concentrate on stocks that move quickly after you buy them. You want to focus on stocks that are already moving in the direction of your trade. To accomplish this, you should wait for a stage 2 uptrend to develop before you invest.

TRANSITION FROM STAGE 1 TO STAGE 2 A stage 2 advance may begin with little or no warning; there are no major announcements or news. One thing is certain, however: a proper stage 2 will show significant volume as the stock is in strong demand on big up days and up weeks, and volume will be relatively light during pullbacks. There should always be a previous rally with an escalation in price of at least 25 to 30 percent off the 52-week low before you conclude that a stage 2 advance is under way and consider buying.